El Salvador’s currency conundrum

San Salvador turns to the IMF for help to implement bitcoin, good luck!

The International monetary Fund (“IMF”) has urged El Salvador to drop bitcoin as legal tender in the country. The administration of President Nayib Bukele wants citizens to start using the currency as soon as is feasibly possible. The IMF is worried about transparency and regulatory issues surrounding the currency and, for the first time, warned the government that its implementation could close the door to financial assistance in the future. Given increasing public debt and tight fiscal constraints, this is not an attractive prospect for the country.

The IMF follows in the footsteps of the World Bank which declined to offer “technical assistance” to San Salvador after a request last year. The organisation stated at the time, “While the government has come to us for our assistance on bitcoin, this is not something the World Bank can support given the environmental and transparency gaps.”

In early June, El Salvador became the first country to classify bitcoin as legal tender, along with the U.S. dollar, after the Salvadoran Congress passed Bukele’s proposal to implement the cryptocurrency.

An economist based in El Salvador said, “Markets and foreign financial institutions have long warned that there are serious macroeconomic, financial and legal issues in the administration’s plans to roll out the currency.”

“Markets and foreign financial institutions have long warned that there are serious macroeconomic, financial and legal issues in the administration’s plans to roll out the currency.”

Economist, El Salvador

In a further development late last year, Bukele announced that the country had started mining Bitcoin with geothermal power. Given the intense electricity usage this can entail, the plans will sharply exacerbate power supply shortages across the country and increase electricity costs for El Salvadoreans. It will also galvanise political opposition.

The economist said, “Mining farms require enormous amounts of electrical power at a time when the country’s dilapidated energy infrastructure is already causing frequent shortages. This is bad policy.”

“Mining farms require enormous amounts of electrical power at a time when the country’s dilapidated energy infrastructure is already causing frequent shortages.”

Economist, El Salvador

In an analysis published by El Salvador’s Foundation for Economic and Social Development (“FUSADES”), experts claimed that the country does not have the infrastructure needed to meet the mining project’s electricity demand. This could result in the administration turning to carbon-based energy – for the first time in decades. It would be a significant pollutant and unnecessary given that geothermal energy, which generates nearly 25% of total electricity production, is just one part of a power grid with the rest comprised of hydropower biomass and solar.

Bukele has stated that more than two million people in the country are now using the state digital wallet which is intended to facilitate bitcoin purchase and exchange. This will engender further popular distrust amid a sore lack of transparency from the current administration. Moreover, investors are likely to be put off with concerns arising from operational risks due to the likelihood of power supply shortages and increased electricity costs.

Not the IMF nor the World Bank nor the prospect of national power outages are acting as a strong deterrent to Bukele’s plans. So confident is the president of bitcoin’s potential, that he announced in January that the administration plans to issue bonds linked to the currency. True, firms interested in investing in El Salvador’s Bitcoin mining could find opportunities attractive in the short-term. Weak regulatory frameworks and the nerves at the worlds leading financial institutions should make them think twice.

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